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Trading the Trend

Someone asked over the weekend if it was advisable to buy and sell based on support and resistance levels.  I think there's some basic confusion around this so I'd like to spend a few minutes discussing it.  Buying at support levels and selling into resistance is actually a method that many professional traders use; it's basically trading the trend line or channel and it is a very good strategy.  The time when this method is most beneficial is during times of uncertainty within the market.  A sideways market just like the one we've been in recently is the time to trade the channel.  In sideways markets we must find the channels that a stock has a tendency to trade within.  Where does the stock drop down to before rebounding Where does the stock run up to before pulling back If you can look at a chart and answer these 2 questions you've just located the stock's trading channel.  You can now use that information to profit in a side ways trending market. 

The trend is your friend.  Whether that trend is down up or sideways learning to trade with the trend will help you profit under any market conditions.  If you pay attention to the trading tendencies of a stock you should notice a trading pattern.  Many people will look at a stock chart and simply see a bunch of lines going up and down but the smart trader will see a pattern and trade it to their advantage. 

What's Up Doc
It's like a doctor looking at an EKG.  To the untrained eye it's just a line that keeps going up and down but to the trained eye it shows a pattern.  Your doctor is able to discern a lot of information by simply looking at the line.  Traders can also learn to be doctors of the stock chart.  We can look at a chart and know when it is behaving normally.  We know when a stock looks sick and we know when a stock looks very healthy.  When a trend line is broken either negatively or positively the chart is telling us that the stock price wants to start a new trend. 

In a sideways market this channel becomes our friend.  By identifying the natural pattern of the stock you can determine the best place to buy (support) and the best place to sell (resistance).  You can then trade this channel consistently and make a decent profit.  The key is the channel lines.  If you buy a stock on a dip to support you should always set a stop loss below that level of support.  So if the stock is going to start a new trend to the downside you are protected.  You can also use this when a stock begins to encounter resistance.  If volume picks up and the stock seems to be testing the layer of resistance keep your eye on it for a breakout above the channel and a new up trend to start.  Otherwise you know that it's hitting resistance and it's time to sell.

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